Thursday, 28 October 2010

John Mangun
Outside the Box
Business Mirror
http://www.businessmirror.com.ph/home/opinion/3019-the-worst-is-yet-to-come

It would be funny if it were not so tragic; commentators and pundits saying the US economy is getting better or at least not getting any worse. The worst is yet to come.

For two decades Americans borrowed at the urging of government and Federal Reserve (Fed) Chairman Alan Greenspan. Inflation was not a problem, so Greenspan thought he was doing a great job. As prices for housing doubled and tripled, no one cared. That type of price rise is not counted in the inflation numbers. The US spent trillions of dollars buying Chinese goods that never seemed to go up in price. No reason for China to raise prices because they were selling more and more goods. No inflation.

But when you borrow money, you must have an asset to back that borrowing, and what better asset than real estate. Borrow against property one to buy property two at higher and higher prices. Then the bubble burst, as there was no more money to lend.

The US government then borrowed and printed $3 trillion in 2009 and put that money into the system in the hope that Americans would borrow and buy. But you can fool the people only for so long.

The fear since 2008 was that there would be a period of deflation, falling prices and a stagnant economy. However, prices did not fall, except for houses since all that new money in the economy caused the dollar to fall, increasing the prices of all imports, especially oil. Gasoline has increased by $1 a gallon since Obama’s economic recovery plan started. So now the Americans have higher prices and no economic growth. What comes next?

The Japanese tried government “stimulus” and zero-interest rates for nearly 20 years, and it never worked. Once burned by a flat economy due to corporate overborrowing, the Japanese never went back to their extravagant consumption habits. Japanese individuals were never big borrowers. In fact, through the 1990s they sat on billions in personal savings that they never spent. No reason to. Prices next year would be the same as today with no inflation. Economists theorized that what the Japanese government should have done was raise interest rates sky-high, forcing corporate borrowers to raise prices, which would force consumers to spend to avoid future price increases.

That is what the US government is now going to do and it will be a huge, disastrous failure, causing greater economic trouble.

From Bloomberg: “With interest rates already near zero, the Fed will be aiming to increase the rate of inflation and reduce the cost of borrowing in real terms.” Times of inflation are supposed to encourage borrowing because, in the future, you can pay back the loan with money that is worth less. “The goal is to unlock consumer spending and jump-start an economy that’s growing too slowly to push unemployment lower. Estimates for the ultimate size of the asset-purchase program range from $1 trillion to $2 trillion.”

Except, the American people are not like the Japanese were, sitting on billions just waiting to go back to the department store and spend. What the Fed is hoping is that higher interest rates and higher inflation will force companies, who are sitting on $2 trillion, to start spending. They will not, because why should they invest in new products and new factories. The American consumer does not have any money (or the financial stability to borrow) to become real consumers again.

All that will happen is that inflation of normal goods like food, gasoline and all their imported-from-China clothes will go higher in price. As the Fed prints and borrows a trillion dollars more, the dollar will decrease in value, raising the price of the Americans’ imported goods that the Americans cannot afford, anyway. The hope is that a cheaper dollar will increase American exports enough to offset the cost of imported products further, as imports go higher, American manufacturers will produce toys and shoes cheaper than the chine can and the money will stay at home. Good luck on that. That is why the Chinese keep their currency virtually pegged to the dollar.

Read this. National Review Online: “Uncle Stupid is dumping $109 billion in new debt on the bond market this week.” Part of the $109 billion includes $10 billion of a special Treasury debt called Treasury Inflation-Protected Securities (TIPS). The interest rate that TIPS pay is indexed to inflation in order to protect investors from the negative effects of inflation. In other words, you make more money with TIPS the higher inflation goes. Incredibly on Monday, these bonds sold at a negative yield for the first time in history. The institutions that bought these bonds will lose money unless inflation goes up.

Currently, official inflation in the US is a little over 1 percent. But if you measure inflation as it was computed in 1980, the true inflation rate is 9 percent. What has changed since 1980 is that inflation then was a measure of the cost of living needed to maintain a constant standard of living. Now it is a measure of prices regardless if anyone actually buys those items included in the goods basket. Simplistically put, if the price of bread goes up 10 percent and the price of a car goes down 10 percent, zero inflation. But people must buy bread and not cars, and bread inflation is 10 percent.

Finally, somebody has to pay for all of this stimulus and money printing. From SteynOnline: “Historically, foreign official holdings of US Treasury securities have been less than 5 percent of the rest of the planet’s gross domestic product [GDP]. By 2009, they were up to 7 percent. Obama-sized budgets depend on foreign holdings rising to about 20 percent of the rest of the planet’s GDP.” That will not happen.

What will happen is that the US is headed for the higher inflation that I have talked about for the last year. The dollar is going down. The US economy will not recover any time soon.

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